Appendix to Chapter 20 Practice Quiz

Appendix to Chapter 10 Practice Quiz
The Self-Correcting
Aggregate Demand and Supply Model

1. An assumption of the short-run aggregate supply curve is that it is a period of time which

a. knowledge is complete.

b. wages are fixed.

c. wages are constant for under one year.

d. prices firms charge for products are fixed.

ANS:

b. The short-run aggregate supply curve (SRAS) is based on two assumptions: (1) incomplete knowledge and (2) fixed-wage contracts.

2. The long-run aggregate supply curve is based on the assumption that

a. both the price level and nominal incomes are fixed.

b. prices are flexible after one year.

c. both the price level and nominal incomes change by the same percentage.

d. potential GDP is undermined.

ANS:

c. The long-run aggregate supply curve (LRAS) is a vertical curve at full-employment real GDP along which profits remain unchanged because the price level and nominal income change proportionally.

3. Graphically, long-run macro equilibrium occurs at the

a. midpoint of the aggregate demand curve.

b. Intersection of the aggregate demand and long-run aggregate supply curves regardless of the short-run aggregate supply curve.

c. midpoint of the long-run aggregate supply curve.

d. intersection of the aggregate demand, short-run aggregate supply, and long-run aggregate supply curves.

ANS:

d. The intersection of these curves establishes the equilibrium price level and full-employment real GDP.

4. An increase in nominal incomes of workers results in the

a. aggregate demand curve shifting to the left.

b. long-run aggregate supply curve shifting to the right.

c. short-run aggregate supply curve shifting to the left.

d. short-run aggregate supply curve shifting to the right.

ANS:

c. If workers increase their nominal incomes to restore their purchasing power, the higher cost of labor means firms must increase the price level at each possible level of real GDP to maintain profits.

5. An increase in aggregate demand in the long-run will result in ____ in full employment real GDP and ____ in the price level.

a. no change; an increase

b. an increase; no change

c. a decrease; no change

d. no change; a decrease

ANS:

a. Since the long-run aggregate supply curve (LRAS) is vertical at full-employment real GDP, an increase in the aggregate demand curve (AD) causes an upward movement along LRAS to establish a higher price level.

6. In Exhibit A-8, the intersection of AD1 with SRAS indicates

a. short-run equilibrium.

b. long-run equilibrium.

c. that the economy is not operating at full employment.

d. that prices and wages are inflexible.

ANS:

b. Long-run equilibrium occurs where the aggregate demand curve (AD1) intersects both the short-run aggregate supply curve (SRAS) and the long-run aggregate supply curve (LRAS).

7. In Exhibit A-8, the intersection of AD2 with SRAS indicates

a. short-run equilibrium.

b. long-run equilibrium.

c. that the economy is operating at full employment.

d. that prices and wages are inflexible.

ANS:

a. Since the intersection of aggregate demand curve (AD2) and the aggregate supply curve (SRAS) does not occur along the long-run supply curve (LRAS), it is a short-run equilibrium situation.

8. In Exhibit A-8, the self-correcting AD/AS model argument is that, if D2 equals SRAS, competition

a. from unemployed workers causes an increase in nominal wages and a rightward shift in SRAS.

b. from unemployed workers causes a rightward shift in LRAS.

c. among firms for workers increases nominal wages and this causes a leftward shift in SRAS.

d. among consumers causes an increase in the CPI and a rightward shift in SRAS.

ANS:

a. In short-run equilibrium below full-employment real GDP, unemployed workers will force a lower wage rate causing the short-run aggregate supply curve (SRAS) to shift rightward.

9. In Exhibit A-8, the self-correcting AD/AS model theory is that in the long run the economy will

a. remain where SRAS intersects AD1.

b. shift to the intersection of AD2 and SRAS.

c. shift to the intersection of AD2 and LRAS.

d. shift to the intersection of AD2 and a new leftward- shifted SRAS.

ANS:

c. In the long-run, the rightward shift of the short-run aggregate supply curve (SRAS) will establish long-run equilibrium where the aggregate demand curve (AD2) intersects the long-run aggregate supply curve (LRAS).

10. In A-8, the self-correcting AD/AS model predicts that the long-run result of the decrease from AD1 to AD2 will be a (an)

a. higher price level and higher unemployment rate.

b. lower price level and higher unemployment rate.

c. unchanged price level and full employment.

d. lower price level and full employment.

ANS:

d. At any real GDP below the point where the long-run aggregate supply curve (LRAS) intersects the horizontal real GDP axis, the unemployment rate is higher than the full-employment rate. Also, observe that along the vertical axis that the price level (CPI) falls in this case from moving to long-run equilibrium.

11. Which of the following is the most likely to cause a leftward shift in the long-run aggregate supply curve?

a. An increase in labor

b. An increase in capital

c. An advance in technology

d. Destruction of resources

ANS:

d. A leftward shift in the long-run aggregate supply curve is caused by decreases in resources (land, labor, or capital) that reduce the productive capacity of the economy.

12. As shown in Exhibit A-9, and assuming the aggregate demand curve shifts from AD1 to AD2, the full-employment level of real GDP is

a. $12 billion.

b. $8 billion.

c. $150 billion.

d. unable to determined.

ANS:

b. The full-employment level of real GDP is established by the vertical LRAS curve.

13. Given the shift of the aggregate demand curve from AD1 to AD2 in Exhibit A-9, the real GDP and price level (CPI) in long-run equilibrium will be

a. $8 billion and 150.

b. $12 billion and 200.

c. $8 billion and 250.

d. $8 billion and 200.

ANS:

c. E2 is a short-run equilibrium because in the long run competition among firms for scarce workers will drive upward the wages of labor causing SRAS1 toshift leftward to SRAS2.

14. Beginning from long-run equilibrium at point E1 in Exhibit A-9, the aggregate demand curve shifts to AD2. The real GDP and price level (CPI) in short-run equilibrium will be

a. $12 billion and 200.

b. $8 billion and 250.

c. $8 billion and 150.

d. $12 billion and 250.

ANS:

a. E2 is a short-run equilibrium for an overheated economy operating beyond its full-employment capacity.

15. Beginning from short-run equilibrium at point E2 in Exhibit A-9, the economy’s movement to a new position of long-run equilibrium would best be described as

a. a movement along the AD2 curve with a shift in the SRAS1 curve.

b. a movement along the SRAS2 curve with a shift in the AD2 curve.

c. a shift in the LRAS curve to an intersection at E1.

d. no shift of any kind.

ANS:

a. At E2 the increase in nominal wages (a resource price) shifts SRAS1leftward to SRAS2 and equilibrium E2. The result is a movement upward along AD1.